How to handle a tax refund
Admittedly, many articles on this blog regarding taxes are cautionary. However, that’s prudent since the goal is to help you navigate events like audits and avoid pitfalls like liens against your personal property. But it’s not all doom and gloom with the IRS. A tax refund can be a bright spot in your year and can even pay big dividends if you plan correctly. Of course, plenty of retailers would like you to plan on spending your refund with them. In this article, we’ll offer you a different outlook that can potentially help you keep your money and make even more from it.
Take a tax refund for what it is
It’s important to realize that a tax refund isn’t extra income. It is simply a short-term, interest-free loan you made to the federal government. Many people treat it like a windfall and buy things they’d normally never purchase using their regular income. Instead of doing that, think of a refund like money you could have been putting aside for future growth. When you do that, the door opens up all types of long-term possibilities like the following.
Millions of people worry they are not saving enough. But if you got a tax refund, you were essentially putting a little off to the side for Uncle Sam to use. Now that you’ve ended that free ride, use it to make some money by opening up a brokerage account to purchase an exchange traded fund, a mutual fund, a real estate investment trust, or some other security. You can even use it to fund a new or existing traditional, Roth, or SEP IRA.
Pay off debt
Everyone’s situation is different, but investing while having considerable debt can be like running on a treadmill.Sometimes the interest on debt can outpace gains made on investments. So, it’s worth looking at using a tax refund to pay off small debts or pay down larger ones. Reducing debt essentially acts as a personal pay raise, freeing more income to be invested regularly.
Start a college fund
Educationdata.org found the average cost per year for college is $35,331 per student. And higher education costs are outpacing even today’s rate of inflation. So, it’s never too early to start a college fund for your child. A tax return can help seed a 529 college savings plan that invests your money and grows tax-free until you withdraw the money. Even then, qualified withdrawals are not taxed.
What to avoid
In today’s high inflation environment, simply tucking the money into a saving account is a slow way to lose money. That’s because inflation causes it to lose value. If you need time to decide how to use your refund, putting it in a savings account is a good stop-gap measure. However, it isn’t a long-term solution. Another potential mistake is to spend the money on a non-essential item or overspend on an essential item that loses value, such as a vehicle. Of course, it’s always wise to seek advice and then act according to your individual needs. Just remember it’s your money, and it can be used to serve you for a very long time if you are careful in planning.